Overheads Costs

Definition: Overhead cost is costs incurred or consumed indirectly during production of a product or provision of service. In other words, the cost is needed partly in the production process.

Overhead costs are either factory overheads or administrative overheads

Factory overheads are indirect costs incurred or consumed in the whole factory building itself to make factory related activities continue. For example, electricity lightings and factory security services.

Administrative overheads are costs consumed in the whole organization to make it possible for the general business activities continue. For instance, the cost of electricity lighting for the whole business, water bills and salaries of the employees in the organization.

Classification of Overhead Expenses

Regardless of whether overheads are of factory of administrative nature, they can be further classified based on their behavior in respect to levels of output. These translates in to the following categories;

  1.  Variable Overheads
  2.  Semi-Variable Overheads
  3. Fixed Overheads

Further Explanation

Variable overheads are costs which vary or change with changes in the level of production. In other words, as production level changes, the variable costs also change directly. Such that if production increases, variable cost also increases and the vice versa is true although the variation may not be proportional. Examples are packaging materials and water bills and electricity

Semi-Variable Overheads are costs which are partly fixed and partly variable as the name suggests. That is at some level of production, especially in the short run, the costs tend to remain constant after which they vary due to the organization operating at a higher level of production scale.

Example of such costs are the electricity bills where by at zero production level, the electricity provider demands for an outstanding charge. However, on increasing production level from zero units to “n” number of units, the organization pays outstanding charge plus the additional cost which change with changes in output.

Fixed Overhead is cost which is constant regardless of the level of output. That is, even when production level is zero, the organization pays this kind of cost. A good example is employee salaries, rent and insurance expenses.